EBA publishes annual assessment of banks’ internal approaches for the calculation of capital requirements

The European Banking Authority (EBA) has published the supervisory benchmarking (BM) exercise of 2022 in relation to the internal approaches used in market and credit risk and IFRS9 accounting.
The exercise was performed on a sample of 41 European banks, covering the entire population of EU banks with internal models for market risk. The results identified outliers that were examined by competent authorities, but no interviews with banks were carried out. Feedback was collected to improve future benchmarking exercises, and competent authorities were asked to provide responses on the actions they plan to take with respect to each participating bank’s internal model.
The report discusses the monitoring and assessment of risk-weighted exposure amounts (RWAs) for institutions applying the internal ratings-based (IRB) approach in EU Member States, which determine their own funds requirements. Excessive variability of RWAs among EU institutions has been a concern, and the European Banking Authority (EBA) has set guidelines and technical standards to harmonize practices, referred to as the EBA’s IRB roadmap. The ECB has also conducted a review of the IRB approaches through the Targeted Review of Internal Models (TRIM). The report summarizes the main results of the 2022 benchmarking exercise, which focused on the potential impact of COVID-19 and the implementation of the IRB roadmap on IRB parameters. The analysis found that the usual top-down analysis remains stable, with a decrease in initial variability for high default portfolios and slightly higher initial variability for low default portfolios. The report also contains an analysis of IRB banks‘ exposures to energy firms, which was chosen due to increased uncertainty in the sector, but the data analyzed does not yet reflect the economic developments observed after the Russian invasion in Ukraine.
The EU’s response to the COVID-19 pandemic, including support measures from Member States, has contributed to decreasing default rates and average probability of default (PD) estimates in 2021. However, it is unlikely that there is a direct causal relationship between the two trends. Other factors contributing to the drop in PD estimates include model recalibration, supporting measures, and different origination policies. Institutions must be vigilant in ensuring that long-run average default rates used for (re)calibration of PD estimates reflect the likely range of variability of default rates, as required by regulations. The impact of short-term and structural changes caused by the COVID-19 crisis, as well as the energy crisis, should be closely monitored by regulators and supervisors. The introduction of Basel III reforms is expected to reduce risk-weighted assets variability, and compliance with the IRB roadmap should further reduce unwarranted variability. Finally, the harmonisation of terminology and concepts in the IRB roadmap is yet to be observed in most institutions due to ongoing supervisory review processes.